Dynamic interactions between oil price and exchange rate

Abstract

This paper contributes to better understand the dynamic interactions between effective exchange rate (EER) and oil price for an oil-importing country like the U.S. by considering a Time-Varying Parameter VAR model with the use of monthly data from 1974:01 to 2019:07. Our findings show a depreciation after an oil price shock in the short-run for any period of time, although the pattern of long-run responses of U.S. EER is diverse across time periods, with an appreciation being observed before the mid-2000s and after the mid-2010s, and a depreciation between both periods. This diversity of response should lead policy makers to react differently in order to counteract such shocks. Furthermore, the reaction of oil price to an appreciation of U.S. EER is negative and different over time, which may generate different adverse effects on investment. The knowledge of such effects may help financial investors to diversify their investments in order to optimize the risk-return profile of their portfolios.